Question

Additional Information for All Question: Return on market is 10%, retun on T-bills is 4% and companies pay 40% corporate tax and 30% capital gains tax.. Aston Inc is a company that has a cost of capital of 16%. It is considering either leasing or purchasing a new machine for a project that still has 3 years of useful economic life left Aston Inc is currently using an old machine that is fully depreciated and amortized After accounting for revenue generated and other costs of operation, the NPV of using the old machine is about $8000 per year. The new to annual pre-tax life income machine is more efficient and is expected of $150,000 a year for Aston. As an incentive to firms to invest in environmentally friendly and efficient technology. governments offer subsidies of $20,000 (tax free) each year for 3 years, paid in advanced in the beginning of each year for companies purchasing the new machine Aston is considering. The machine costs $800000 and can be depreciated by the reducing balance method over 10 years to a residual book value of $278.942 75 Total operating and maintenance costs of the new machine is expected to be $70000 (pre-tax) per year.. new GXL Lease is a leasing company that is offering the new machine for lease at $80,000 a year. paid in advance GXL Lease requires a retum of 159% a year ABF Finance is a finance company that is offering financing for the purchase of this machine Leasing annual amortization payments at the end of each year. ABF Finance requires a return of 18% a year for financing this purchase.. Q3: (a) Compile the reducing balance depreciation schedule for the first 3 years (b) If Aston borrows $500,000 from ABF Finance for 3 years, and repays the loan with 3 equal annual end-of-year payments of $200,000 each, calculate the final extra payment required at the end of the 3rd year to fully amortize the loan. Also, show the loan schedule.. Q4. (a) Is it feasible for Aston to lease the machine from GXL lease for 3 years and use it for the project? (b) Is it feasible Aston to purchase the new machine for the project if it borrows $500,000 for 3 years from ABF Finance and amortizes the loan with equal end of year payments of $200,000 and a final payment at the end of 3 years (refer to Q3 (b)); and sell the machine for $603,200 at the end of 3 years? (c) Should Aston borrows $500,000 and purchase the new machine (refer to Q4 b) or continue using the old machine?

Answer 1

Answer to Ques 3A

A) Calculation of Depreciation rate:

Rate of Depreciation = 1 - (Residual value after the expiry of useful life / Original cost of asset)^{1/Estimated Useful Life}

=1-(278942.75/800000)^1/10

=1-(.3486784)^1/10

=1-.9

= .10= 10%

Calculation of Depreciation

Year	Depriciation	Written Down Value
1	=8,00,000*10%=80,000	7,20,000
2	=7,20,000*10%=72,000	6,48,000
3	=6,48,000*10%=64,800	5,83,200

Answer to Ques 4A

ABF Finance Amount		=	5,00,000.00
Rate of Interest		=	18%
Year	Calculation of Interest	Interest	Repayment	Principal Repaid	Balance Loan
1	5,00,000*18%	90,000.00	2,00,000.00	1,10,000.00	3,90,000.00
2	3,90,000*18%	70,200.00	2,00,000.00	1,29,800.00	2,60,200.00
3	2,60,200*18%	46,836.00	2,00,000.00	1,53,164.00	1,07,036.00
	1,07,036 is Additionally required
	Total Payment in third year=	2,00,000+1,07,036
		=3,07,036.00

Calculation of Net Present Value -Through Leasing
		Year 1	Year 2	Year 3
Income		1,50,000.00	1,50,000.00	1,50,000.00
Less: Expenses		70,000.00	70,000.00	70,000.00
	80,000.00	80,000.00	80,000.00
Profit Before Tax	-80,000.00	-	-	80,000.00
Tax @40%	-32,000.00	-	-	32,000.00
Cash (Outflow)/Inflow	-48,000.00	-	-	48,000.00
PV @ 16%	1.00	0.86	0.74	0.64
Net Present Value	-48,000.00	-	-	30,751.57
Net Present Value	-17,248.43
Its not feasible to use the machinery on lease

Calculation of Cash Outflow in the starting of First Year
Purchase Price	8,00,000.00
Amount received through Financing	5,00,000.00
Amount to be Paid	3,00,000.00
Calculation of Cash Inflow in the Last Year
Sale Value of Machinery	6,03,200.00
Amount Paid to ABF	3,07,036.00
Amount received (Net)	2,96,164.00
(B)
Calculation of Net Present Value while purchase of new machine
	Year0	Year 1	Year 2	Year 3
Income		1,50,000.00	1,50,000.00	1,50,000.00
Less: Expenses		70,000.00	70,000.00	70,000.00
Less: Depreciation		80,000.00	72,000.00	64,800.00
Less: Interest		90,000.00	70,200.00	46,836.00
Profit before Tax	-	-90,000.00	-62,200.00	-31,636.00
Tax@40%	-	-36,000.00	-24,880.00	-12,654.40
Profit After Tax		-54,000.00	-37,320.00	-18,981.60
Add: Non Cash Expense/Subsidy(Tax Free)
Incentives Received	20,000.00	20,000.00	20,000.00
Depreciation	-	80,000.00	72,000.00	64,800.00
Less: Cash Outflow (Loan and Purchase of Machinery)	-3,00,000.00	-2,00,000.00	-2,00,000.00
Add: Cash Inflow in Last Year				2,96,164.00
Cash (Outflow)/Inflow	-2,80,000.00	-1,54,000.00	-1,45,320.00	3,41,982.40
PV@16%	1.00	0.86	0.74	0.64
Present Value	-2,80,000.00	-1,32,758.62	-1,07,996.43	2,19,093.65
Net Present Value	-3,01,661.40
C) Its not feasible to purchase the machine through ABF Finance also. Its better to use the Old machine